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HVAC manufacturers feel chill from the deep freeze in construction and lending

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Heating, ventilation and air conditioning (HVAC) manufacturers are bracing for the cold spell to continue until banks ease lending restrictions and the residential and nonresidential construction markets warm up.

Lending practices and fluctuating appraisal values on projects are making it more difficult to break ground, according to John Sedine, president of Engineered Heating & Cooling Inc., Walker, Mich., and chairman of the Arlington, Va.-based Air Conditioning Contractors of America (ACCA), the nation's largest association of HVAC contractors.

"Banks have tightened up lending practices and we have to recover from the flywheel effect we have seen. A project has a two- or three-year phase where it is developed and budgeted. Then two things happened there was a drastic drop in appraisal of property, and banks required more," he said. This meant that a million-dollar project was re-appraised at $750,000, thus making it no longer a viable investment for builders; and banks, which previously required a 10-percent down-payment, now require 20 to 30 percent before it will agree to a loan. It was a double whammy for HVAC manufacturers, who use galvanized sheet and coil to fabricate ductwork.

"I see Texas doing better, California is hard hit and Florida is up and down. The market is not only defined by your geographical area but by what segment of HVAC you serve," Sedine said. His company has fared well during the downturn because it doesn't rely on single-family residential construction, instead making ductwork for use in living quarters for the elderly, office buildings and hotels.

Like others, Sedine is keeping inventories of coated steel products as lean as possible. "We buy monthly because we don't have a lot of room to keep it, but if last year was the top of the mountain this year is like the bottom of the mountain," he said. In gauging steel buys, Sedine looks at the order book and relies on the service centers selling to him to monitor the direction of steel prices. "We try and project what work we have coming up, and when there is wind in the air the people we buy from tell us 'now is the time to buy'," he said.

Sedine expects funds from the American Recovery and Reinvestment Act (ARRA) to surface this year. "A number of jobs were supposed to start last fall but got shut off," he said.

In Minnesota, Sheet Metal Connectors Inc. is starting to see an uptick in its order book, partially due to some stimulus money trickling in. The Minneapolis-based company is fully vested on the commercial side of real estate. "Last year? It was a tough year compared to the last 10 to 20 years—as tough as I remember," Jim Meyers, the company's vice president of sales, said. "This year will be a little bit better, due mostly to government projects, libraries and some of the hospitals adding additions and building some new buildings." There appears to be underlying strength in Texas, Oklahoma, and North and South Dakota, Meyers said.

With stimulus money on the cusp of being awarded, he expects the upturn to gradually progress and continue until the end of 2011. "We have already seen some of it come in, but we don't know when it is all going to get dropped. Projects are starting to get bid and could be started soon," he said.

Meyers said he doesn't expect to see other commercial endeavors break ground until residential construction returns. "The big-box stores and school work will come after residential," he said.

The recession has prompted customers to change their business model, Meyers said. "Sheet metal contractors used to make their own projects. They'd bid the job, fabricate and install. But larger contractors have decided to close down their shops and buy directly from the fabricator," he said, noting that he was impressed by the resilience of the company's medium- to large-sized customer base. "They were the hardest hit because the big jobs weren't out there. I was surprised at how well the bigger ones adapted and managed to stay in business."

Sheet Metal Connectors buys 60-inch galvanized coils on a quarterly basis, and like others has trimmed the size of its inventory to a one- to one-and-a-half-month supply. "We consistently keep buying, but overall we buy quarterly. When good buys come along we will purchase some extra and hedge our buy that way," he said.

Georgia Berner, owner and chief executive officer of Berner International Corp., New Castle, Pa., is seeing improved business activity. "This year is shaping up to be a mild improvement over last year, but I am looking for more of a recovery in 2011," she said.

Like other companies, the recession encouraged Berner International—which makes fresh air ventilation ductwork for the energy recovery systems it provides for schools and commercial projects—to be conservative in business practices. "We tightened up tremendously. In addition to holding less inventory, we've let attrition work and have not replaced people," the chief executive said of the family owned business that has been operating for more than half a century.

Berner hasn't seen any impact from ARRA funds, though. "We hope to when buildings get money to be safe, healthy and energy conscious. Light bulbs and highways are tangible items. Air movement and the condition of the air is more difficult to understand. But air circulation in a building has a great deal to do with the cost," she said.

Berner's company markets its ability to provide cleaner air and energy efficiency, which it sees as having strong potential going forward. Schools and office buildings are becoming increasingly educated about the need to provide well-ventilated structures filled with good-quality air, she said. "We sell to anyone who has a building and needs fresh air. People are getting on the band wagon—at schools in particular—because the air is making them sick. The recirculation of air is what is causing asthma. People laughed when 'Sick Building Syndrome' first came out."

But there is a growing trend of tenants recognizing how modern systems aren't only energy efficient but also can increase the quality of the air. "But the awareness is still spotty," Berner said. "Schools are really catching on, but it also varies state by state."

Consolidation, while prevalent among fan makers in the industry, isn't being felt by Berner or her competitors, she said.

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